Funding Them Forward

December 2016

By&nbspMargo Vanover Porter

How institutions spend their endowments today directly affects access to scholarships, professional development, and other critical support for students and faculty of tomorrow.

Finding the right balance in endowment spending can be a little like walking a financial tightrope. Spend too much, you cut into the corpus and are cast as a spendthrift who mismanages donor funds. Spend too little and you’re labeled a hoarder who denies deserving students their scholarships.

Although determining the spending sweet spot continues to be a challenge, business and endowment officers agree that this source of funds plays an ever-increasing role in student financial aid, employee professional development, and the pursuit of both public and private institutional excellence.

“Endowments are important to public institutions, because they provide some stability against year-to-year fluctuations in state support and are a much-needed source of funds for student financial aid,” says Scott Jordan, executive vice president for administration and chief financial officer, University of Connecticut (UConn), Storrs. “Public universities are finding themselves increasingly in need of other sources of revenue and the long-term stability that endowments provide.”

Cynthia Vizcaino Villa, senior vice president for administration and finance, California State Polytechnic University, San Luis Obispo, agrees. “In this day and age of decreasing state investment in higher education, endowments become a sustainable ongoing revenue stream that can support scholarships for students and excellence in academic units and departments. Endowments are becoming increasingly important for the ongoing sustainability of the institution to pursue excellence.”

According to Jordan, UConn’s endowment is still relatively young. “Like many publics in the Northeast, we’re pretty new to this,” he says. “We’ve never had a substantial endowment. Our endowment is somewhat less than $400 million. Endowment income provides less than 2 percent of our operating budget. Endowment income is very important to most private schools and increasingly important to public schools, but for some, like the University of Connecticut, the endowment is currently not sufficient to meet the need we have.”

Jerry Ganz, vice president of finance and administration, University of Connecticut Foundation, reports that the endowment spending policy is 4.25 percent of a moving 12-quarter average. “Around the country, 4 percent is a well-documented average spending policy for public research institutions,” he explains. He doesn’t anticipate an adjustment to that rate, even though the portfolio lost 30 basis points this year [-0.3%]—a return that, when compared to other public research institutions, he thinks will still rank near the top decile of surveys.

“A significant event would have to occur to make us change our spending allocation. To go backwards would be difficult,” he says. “There’s obviously reliance around the university upon those dollars to fulfill obligations that deans and department heads have to students and faculty. In addition, at 4.25 percent and given projected returns, I don’t believe we would consider an increase either.”

Last March, UConn’s foundation did revise a segment of its endowment spending policy. “We wrote in a very specific threshold for underwater endowments to protect them from deterioration past the 25 percent underwater mark,” he explains. “This helps provide intergenerational equity. The donors gave their money with the intent that these endowments last forever. We want to make sure that is the case. To ensure that, we have to set guidelines for underwater endowments.”

He estimates that roughly 40 percent, or $150 million of UConn’s $377 million endowment, is restricted to scholarships, fellowships, and other awards for students. “Endowments, given their permanently restricted nature, are a critical piece of funding, because they provide intergenerational equity for not just today’s students but also future generations of students at our institutions.”

Up to Donor’s Discretion

At the University of South Alabama in Mobile, low-income students receive about one-third of the scholarships awarded, according to G. Scott Weldon, vice president of finance and administration. “That’s a ballpark,” he emphasizes. “We use Pell-eligibility to determine students with financial need. This past year, from endowments, we awarded 753 awards. Of those, there are 654 student award recipients. Of these, 433 completed the FAFSA, and 185 were Pell-eligible.”

He points out that many donors stipulate income criteria for scholarship recipients.

Funding students in need. “Some of them specify that the gift be given to a first-generation college student,” says Weldon. “We have a couple of larger scholarship programs that are internally funded: Our presidential scholars and our Whiddon Honors program scholars are not specifically need based but do help students in need. The targeted programs for students in need are generally at the discretion of the donors.”

Pinpointing particular purposes. Of the institution’s $170 million endowment, almost 60 percent is restricted for a specific purpose. “We break our restriction down into nonexpendable and expendable,” Weldon explains. “The nonexpendable component represents gifts we received whereby the gift document says, ‘Do not spend the corpus.’ We have to maintain this in perpetuity. That represents about 26 percent of our endowment. Another 30 percent, considered restricted expendable, includes things like investment earnings on nonexpendable endowments. The growth can be spent, but it’s still restricted.”

Supporting faculty. Besides support and scholarship for the institution’s 16,700 students, the next biggest piece of the pie is designated for faculty support, which could include anything from endowed chairs to annual lectureships in certain departments. “Most of the eminent scholar chairs are endowments that range from $1.5 million to $2 million and generate fairly significant revenues every year,” Weldon says. “Another large endowment is related to our Mitchell Cancer Institute for cancer research.”

Starting From Scratch

Prior to the late 1990s, Weldon reports, a university foundation held the University of South Alabama’s endowment. “In the late ’90s, the administrations of the university and foundation had a parting of the ways, and it was decided to start the university endowment all over again, [as a separate entity]. The first dollars went back into our endowment in the late ’90s.”

In the last three or four years, Weldon estimates the endowment’s growth rate has ranged from 7 to 10 percent, thanks to both gifts and asset appreciation. “We received a gift three years ago from a benefactor who provided a $25 million pledge to be used to match gifts to undergraduate scholarship endowments. We have used $6 million to $8 million of that so far.”

A committee of the board of trustees establishes overall spending for the endowment. “Our current spending rate is 5 percent, and we base that on a three-year moving average. The spending rate was established to generate a reasonable amount of funding for scholarships while at the same time withholding some of the growth to allow the corpus to grow. We hope that over time the endowment earns 6 to 7 percent.”

The 5 percent spending rate hasn’t changed in 15 years, with one exception. “In 2009, we had a number of endowments with no expendable funds. We found funds from other sources to honor our commitments, but the next year we stopped awarding endowment scholarships unless we clearly had the reserves to do that,” Weldon recalls. “About 90 percent of our endowments were not awardable during that one year.”

Weldon believes the endowment crisis was exacerbated by its early stages of growth. “Endowments that have been around for 50 years have had plenty of time to build in reserves,” he says. “Being fairly young, our endowment has been through two downturns. The first happened right after we established it. Had we been a 50-year-old endowment or a 30-year-old endowment we could have weathered that downturn much more easily.”

Getting the endowment funds back on track became an institutional priority because “they provide education support and scholarship funding that will get students through school, hopefully, with minimal loans,” he says. “They also provide nonbudgeted, annual funding mechanisms for important programs, such as faculty support, professorships, and research.”

Addressing Affordability

Brad Kelsheimer, senior vice president, finance and administration, DePauw University, Greencastle, Ind., believes there is a clear correlation between an institution’s ability to address affordability and the size of its endowment.

“In our case, the cost—not the price—of providing education is in the $40,000 range,” he emphasizes. “We invest, on average, $22,000 per student, which brings the average net price to $18,000. That’s driven almost entirely by our endowment. Affordability is the primary advantage of a sizable endowment.”

He calculates the private institution spends in excess of $50 million on financial aid annually, about $30 million of which is an endowment draw. “About 60 percent of our students receive need-based aid,” he says. “Of the $50 million that we award, about half is need based, and our ability to make these awards is directly related to our endowment.”

Of the endowment draw, just over a third is restricted to scholarship. Another third is an unrestricted endowment that is applied to scholarship. “In total, about 70 percent of our draw goes toward scholarship,” he clarifies. The rest of the bucket, he says, goes to faculty professional development, as well as international and career-focused experiences for students.

Adding reinforcements. Several years ago, the institution introduced the DePauw Trust, a need-based financial aid initiative with a target of $100 million in endowed funds. “We’re at about $60 million in commitment right now,” he says. “These are incremental funds specifically restricted for financial aid.”

Current endowment initiatives are focused on two drivers—growth and return. “In 2007 and 2008, we dropped to $440 million, went to a high last year of $655 million, and now we’re back down to $620 million,” Kelsheimer says. “We anticipate a 7 percent return from investments over time. Over the last five years, we have been adding $20 million to $30 million a year in gifts to the endowment, in addition to investment earnings. That will slow as we emerge from this development campaign. In general, we average $5 million to $6 million of gift activity into the endowment, in addition to investment return.”

As a result of the market correction in 2008–09, DePauw decreased the endowment dollars spent in 2009–10. “We’ve increased it since,” he says. “Frankly, we are spending more than we believe we should right now in order to meet financial need.”

Projecting need. The endowment spending rates, which range between 5 and 5.5 percent, are based on projected growth and student need. “The stated spending goal of our endowment is to maintain purchasing power, which means inflation plus our spend should not be more than our expected growth rate for investment. We also factor in gifts. Over a 30-year period, we may have a 7 or 8 percent investment return, and we spend all of that when inflation is factored into the mix.”

Student need is also a major factor in the endowment draw. “In the years when the mix might shift from low need to high need, we might have to draw more from the endowment for scholarships than we anticipated,” he explains. “If the mix were to shift in the student body enrollment from high need to low need that may be a factor. Overall, however, we manage our endowment with an eye toward intergenerational equity. We believe it’s our responsibility to provide an endowment in perpetuity so we need to maintain purchasing power.”

Kelsheimer believes an endowment of $620 million provides DePauw a certain latitude, as well as a responsibility, which he takes seriously. “Schools like DePauw with higher-than-average endowments can be more innovative because they are not as tuition dependent,” he says. “We have a buffer to try to be innovative. If higher education business models are going to shift, some of us have to take risks. Without an endowment, schools are not able to do that.”

In the end, notes UConn Foundation’s Ganz, “regardless of what policies we implement or how we invest and manage money, we have to make sure that these endowments are here for future generations of students and faculty. That’s the overriding factor in the management of these funds.”

“Regardless of what policies we implement or how we invest and manage money, we have to make sure that these endowments are here for future generations of students and faculty. That’s the overriding factor in the management of these funds.”

—Jerry Ganz, University of Connecticut Foundation

Anticipate Donor Questions

Business and endowment officers who are not spending what’s being earned by the endowment, may get pointed questions from donors, points out Cynthia Vizcaino Villa, senior vice president for administration and finance, California State Polytechnic University, San Luis Obispo.

“Donors want to know what’s happening,” she says. “Most institutions provide fund-reporting mechanisms to the donors to let them know how their funds have been used. If you start accumulating money and not spending it, they may have questions. Your answer could be very logical, such as saving for a large capital purchase or renovation, but if you’re not in front of their questions, it can create an issue.”

Other endowment advice from business and endowment officers includes:

Review your spending policy. On a fairly regular basis, examine your spending policy to ensure it accomplishes its intended goals. “If you’re spending 3 percent per year and the endowment averages 6 or 7 percent a year in earnings, you may not be distributing sufficiently,” says G. Scott Weldon, vice president of finance and administration, University of South Alabama, Mobile. “That’s probably not the right place to end up. Of course, it works both ways. During a rough period, an endowment that had been distributing 5 percent may be changed to 4 percent because it was cutting too close—although we try hard not to do that.”

Vizcaino Villa adds that all institutions must have a good system of monitoring the spend on their endowments to ensure they are in compliance with donor wishes and restrictions and to ensure the corpus is preserved.

Allow time for growth. Although a few donors want to give an endowment one month and award a scholarship the next month, Weldon discourages early payouts. “We try to build into our procedures enough time to conservatively let the endowment build up reserves,” he says. “I like to have an endowment funded for at least 18 months before we make the first award. Sometimes that’s difficult because donors want to see results. Part of my role is trying to make sure this is a long-term strategy and not a short-term strategy.”

He encourages development officers to adopt this motto: Be aggressive in building but slow to spend. “Many of our endowments are based on five-year pledges,” he explains. “A lot of fairly low-dollar donors want to establish an endowment, but want to do it over five years. We encourage them to pay more quickly if they can and to let us wait to award those funds until we get to the end of the pledge period. What that does is build the reserves and cushion the funds against a future downturn.”

Check portfolio mix. “Some institutions like to be more aggressive than others,” Weldon points out. “There’s no right mix.” His institution’s endowment typically holds about 65 percent equity and 35 percent debt and is rebalanced on a quarterly basis.

“There’s always a question about how to best invest your endowment funds,” echoes Vizcaino Villa. “Our foundation board and investment committee oversee our endowment portfolio. That’s something we keep a close eye on because we want to preserve the corpus of the endowment and provide a reasonably attractive return.” She indicates the return is currently 4.2 percent.

Watch affordability. “To some extent, we have to let the market work,” says Brad Kelsheimer, senior vice president, finance and administration, DePauw University, Greencastle, Ind. “If we see that we are not meeting enough financial need to make affordable what we offer to everybody who wants and qualifies for education, we know we have adjustments to make. Those adjustments can be using more endowment or adjusting on the cost side or on the annual fund side. If we see that the market is reacting such that we have a population of prospective students who can no longer afford DePauw, then we need to make a change. In our case, we keep an eye on affordability and accessibility.”

He admits it’s a challenge to cover all $50 million in scholarships that the institution offers.

Adhere to a standard of prudence. “I’ve been to a lot of conferences and talked to a lot of my peers, and I’ve learned one thing: Each of our situations is different,” says Jerry Ganz, vice president of finance and administration, University of Connecticut Foundation, Storrs. “When we compare notes and share best practices, we find our situations are like fingerprints—it’s hard to look at what your peers are doing and do exactly the same thing. What you can do is listen to their circumstances, and apply that to your own institution.”

He points out that each institution’s environment, approach of donors, and need for support in the budget contribute to its endowment spending policy. His only across-the-board comment is to urge all business and endowment officers to adhere to the Uniform Prudent Management of Institutional Funds Act (UPMIFA), enacted in most states, which requires that assets be invested prudently in diversified investments that seek growth as well as income and that appreciation of assets prudently be spent for the purposes of the endowment fund. Ganz emphasizes: “UPMIFA contains a standard of prudence that we’re subject to when managing endowments.”